DealerTrack Holdings Q4 2007 Earnings Call Transcript

DealerTrack Holdings Inc. (TRAK)

Q4 2007 Earnings Call

February 19, 2008 5:00 pm ET

Executives

Mark O'Neil - Chairman and CEO

Robert Cox - SVP and CFO

Analysts

Chris Mammone - Deutsche Bank

Tom Roderick - Thomas Weisel Partners

Andrew Jeffrey - SunTrust

Peter Goldmacher - Cowen

David Scharf - JMP Securities

Franco Turrinelli - William Blair & Company

Jordan Hymowitz - Philadelphia Financial

Presentation

Operator

Good afternoon, everyone, and welcome to the DealerTrack's fourth quarter and full year 2007 conference call. I am joined by Mark O'Neil, Chairman and Chief Executive Officer; and Robert Cox, Senior Vice President and Chief Financial Officer. As a reminder, this call is being recorded.

Before we begin, I would like to remind everyone that remarks during this conference call will contain forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are neither promises nor guarantees, but involve risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements, including without limitation, those risks detailed in DealerTrack's filings with the SEC, such as our 2006 Form 10-K.

DealerTrack disclaims any obligation to publicly update or revise any such statements to reflect any change in its expectations or in events, conditions, or circumstances in which any such statements may be based or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

DealerTrack also uses non-GAAP financial measures to represent business performance. A reconciliation of GAAP to non-GAAP financial measures is included in today's press release, which is available on the Investor Relations section of the company's website at, dealertrack.com.

At this time I will turn the call over to Mark O'Neil at DealerTrack.

Mark O'Neil

Thank you. Hello everyone. Thanks for being with us this afternoon. I will begin today's call with an overview of our financial results and other key metrics for the fourth quarter and full year 2007. I will then provide a quick summary of 2007 from our business and strategy perspective, and discuss some of our latest accomplishments, as well as recent industry developments. Bob will provide further details on our financial performance for the fourth quarter and full year. We will also discuss our outlook for 2008.

Let me start by saying we are very pleased with our 2007 performance and our achievements in growing the DealerTrack network and increasing the quantity and quality of products that we offer. We saw strong growth in revenue, EBITDA and cash net income.

Revenue for the quarter was $60.7 million, up 33% from fourth quarter 2006 and total revenue for 2007 was $233.8 million, an increase of 35% from last year. Net income for the quarter was $4.1 million and EBITDA was $15 million. Diluted cash net income per share was $0.25 for the quarter, bringing the full year to $1.07.

As we look back at the year we are pleased with the ongoing execution of our growth strategy. We have further expanded network participation across each of our customer and partner categories. We had 465 financing sources connected as of the end of the fourth quarter, a gain of 52% from December 2006. On February 9th, we announced the addition of the 500 lender connected to the network and our 200 millionth credit application processed through the network. Both are truly remarkable milestones.

The total number of active dealers in the network at the end of 2007 was 22,043, which declined to 1% from a year ago. This decline in active dealers is due to consolidation of stores at the retail level, franchise reduction efforts by the manufacturers and by certain subprime lenders cutting off dealers in an effort to reduce originations.

We do not expect the active dealers in the network to increase until our independent dealer initiative gains traction. We also signed 15 aftermarket providers during the year for a total of 33 providers signed as of December 31st, with 20 of those providers live in the network and others in the process, we are excited about the prospects for the Aftermarket Network.

We continue to have success with cross selling our products and services. Total subscriptions in the network increased to over 28,966 subscriptions, which represents 34% growth from a year ago. The fourth quarter saw net new subscription counts impacted by a pullback in spending by some dealers and by the consolidation of certain versions of our software.

We are pleased that approximately 59% of our dealer customers now subscribe to one or more subscription products we offer and the average number of subscriptions per dealer has risen to 2.21, compared to 2.03 a year ago.

Transaction volume also increased for the quarter. We processed 20.8 million transactions in the network during the quarter versus 19.5 million a year ago. Transaction volume growth in the fourth quarter was effected by a challenging economic environment. The automotive sector began to feel the effects of the subprime credit crisis with many lenders tightening credit standards and some lenders purposefully reducing originations. This practice is likely to continue through the first half of 2008, as lenders monitor the availability of the capital markets and the financial health of their consumers.

For the year, we processed 90.9 million transactions versus 71.5 million in 2006, representing growth of 27%. Much of the growth in transaction volume can be attributed to adding new financing sources to our network and to continuing increases in volume from other transaction products, most notable eContracting and eDocs.

2007 was a busy and productivity year for DealerTrack. I would like to quickly recap some of our accomplishments. In the last year we launched a number of new products and services, delivered significant product enhancements and improved the integration of the products we offer.

On the Subscription side of the business we launched InventoryPro a comprehensive inventory solution that empowers dealers with analytical tools to improve inventory turnover. Subsequently, during the year we enhanced a solution with the addition of Manheim Market Reports, and more recently real-time online access to Manheim Auctions. We have also reached an agreement with GMAC’s SmartAuction to gain similar online access. These relationships give us the largest source of wholesale inventory in the industry.

On the Transaction side of business, in September we launched the innovative DealerTrack Leads Network. A solution that enables dealers to take greater controls of their leads purchasing process by only buying the leads they need with no minimums or long-term contracts. In 2008 our focus will be to add new aftermarket providers while concurrently increasing dealer utilization of the Leads Network.

We made three acquisitions in 2007; Curomax in February, Arkona in June, and AutoStyleMart in August. Each of these acquisitions brought key resources to expand or enhance our existing offerings. The acquisition of Curomax helped us strengthen our presence in the Canadian market and brought our rapid entry into the US, RV, marine, and powersports financing application business segment.

We entered the multi-billion dollar Dealer Management System, DMS business through the acquisition of Arkona this past June. Within 120 days of this acquisition we were selected by Asbury Automotive Group, one of the top dealer groups in the country as it's dealer management system and technology partner for all 93 of it's retail automotive stores.

We think DealerTrack, Arkona DMS is well-positioned in the industry because of its low cost web-based platform and the open access to provide other technology vendors. Additionally, we have made significant progress in expanding our OEM relationships, most recently with our announcement that Nissan and Hyundai have agreed to establish connectivity to our DMS. This increases our manufacture connectivity to 90% of all franchised dealers.

We are pleased with Arkona's progress over the first seven months of our ownership. And we continue to invest in the business by building functionality and expanding install capacity to support future growth.

The acquisition of AutoStyleMart in August provided key resources and technology to speed our entry into the business of connecting third-party accessory providers to the Dealer customers. The DealerTrack accessory network allows the dealer to present their customer a wider array of accessory options, facilitates the procurement of those accessories and assists with order fulfillment.

We believe that our entry into the DMS and accessory businesses only increase the already significant opportunity available to us, as we convert the traditionally inefficient paper processes and dealerships, to faster, more accurate and efficient electronic processes with an end-to-end technology offerings.

Overall 2007 was a very good year for DealerTrack. Of our 35% revenue growth for the year, 62% of that growth was organically generated. We also invested in important growth areas within current and new markets such as our Arkona dealer management system, InventoryPro, the Aftermarket Network, the Accessories Network and the Independent dealer initiative.

While investing in these growth opportunities, we are still able to deliver very attractive annual EBITDA margins of over 28%. We believe our performance in 2007 demonstrates our ability to grow and thrive despite the industries challenges. In short, we will maintain our focus on helping Dealer's achieve greater profitability while creating greater efficiencies for the lenders, aftermarket providers and others that serve our dealer customers.

As we look ahead into 2008, our growth strategy for the business remains consistent. One, increase the scope and breadth of participants on the DealerTrack network. As it has been our strategy for the last seven years, we will continue to add financing sources, aftermarket and accessory providers, dealers and other service and information providers to the network. We believe the addition of these participants will increase the utilization in the network, create stickiness and give users less reasons to go elsewhere.

Second, cross-sell of DealerTrack products. We believe that our dealers' customers want an end-to-end technology solution to run their stores. From our SalesMaker product which helps the dealer find the best finance option to our dealer management system, which allows the dealer to write a vehicle repair order, our product's great efficiency resulting in time and dollar savings in the dealership.

Third, offer new products. Since our inception, our offerings have expanded to include seven transaction products and 13 subscription products available to our customers. We will continue to develop new products and to add functionality to existing products, to help our customers reduce costs and increase profits. As mentioned on prior calls, we have made and will continue to make significant investments to ensure that our products are well integrated in order to offer a seamless end-to-end technology solution.

Fourth, complete strategic acquisitions. Given the challenging economy in automotive sales environment, we believe there will continue to be opportunities to complete strategic acquisitions. We expect these opportunities will allow us to expand our product offering by acquiring proven technology to strengthen our market position in various product areas or potentially to enter new adjacent markets.

Earlier this month, we exhibited at the Annual National Auto Dealers Association, also referred to as NADA event, which was held this year in San Francisco. This is the largest dealer event in the industry and continues to be a great opportunity for us to meet with our customers. This year we introduced our New Red Flags product that helps dealers analyze customer information and enables them to make assessments as to whether or not their customer maybe using a false identity.

We demonstrated enhancements to our InventoryPro inventory and announced the addition of the 500 vendors to our network. We also provided dealers with information on our new accessory solution and work to further educate them on our other key products including the Arkona DMS, eContracting, Dealwatch, eMenu, SalesMaker and the Aftermarket network.

We had our most successful show ever with strong customer interest in our products and good interactions with industry participants, particular with manufacturers who attended the show. Especially notable was dealer and manufacture interest and the DealerTrack Arkona DMS product. This tells us that single point dealers and dealer groups alike, now consider us a tier-1 alternative for software to run their stores.

Bob will now provide further detail about our 2007 financials and our guidance for 2008.

Robert Cox

Thank you Mark. Our revenue of $60.7 million for the fourth quarter breaks down into the following. Transaction revenue of $35.3 million, up 22% from the fourth quarter of 2006; Subscription revenue of $21.5 million a 45% increase from the same period last year; and other revenue of $3.9 million compared to $1.7 million a year ago. We grew revenue approximately $15 million from the fourth quarter of 2006 approximately 55% of this revenue growth is considered organic, while 45% of the growth is attributable to acquisitions.

For the year total revenue of $233.8 million represents transactions revenue of $147.3 million up 31% from 2006. Subscription revenue of $75.1 million, which grew 41% from last year and other revenue of $11.4 million, which increased 60% from 2006. For the full year 2007, 62% of our revenue growth was organic and 38% came from acquisitions.

Net income for the quarter was $4.1 million compared to $5.7 million a year ago. Both GAAP net income and cash net income for the fourth quarter of 2006 include other income of approximately $1.4 million resulting from a purchase price adjustment of a prior year’s acquisition.

Net income for 2007 was $19.8 million; EBITDA for the quarter was $15 million up from $14.5 million for the same period a year ago. EBITDA for 2007 was $66 million representing growth of 37% from 2006. Cash net income was $10.9 million for the quarter up from $9.3 million for the fourth quarter of 2006. And cash net income for the year grew 35% to $44.2 million.

Detailed reconciliations of GAAP net income to non-GAAP financial measures of EBITDA and cash net income are included as attachments to today’s press release posted to our company's website. Diluted GAAP net income per share for the fourth quarter was $0.10 and was $0.48 for the year. Diluted cash net income per share was $0.25 for the quarter and $1.07 for the year.

Cash flow from operations for the fourth quarter was $23.3 million an increase of 32% compared to cash flow from operations of $17.7 million for the fourth quarter of 2006. For the full year 2007 cash flow from operations was $56.9 million up 25% from $45.5 million for the full year 2006. Capital expenditures for the quarter were $5.8 million and totaled $15.1 million for the year.

Now let me give our guidance for 2008. We estimate total revenue for 2008 to be between $270 million and $276 million. GAAP net income for the year is expected to be between $24.8 million and $26.2 million. We expect EBITDA for 2008 will be between $71.2 million and $73.5 million.

Cash net income for the year is forecasted to be between $50.4 million and $51.8 million. Diluted GAAP net income per share is expected to be between $0.56 and $0.60 per share for the year and diluted cash net income per share is expected to be between $1.14 and $1.18 per share. Both of these forecasts are based on an estimate of 44 million diluted weighted average shares outstanding versus 41.2 million shares outstanding in 2007.

Included in our guidance are approximately $7 million in anticipated costs in relation to our outstanding patent litigation. These costs represent approximately $0.10 per diluted share of both GAAP net income and cash net income per share.

Additionally, and as mentioned on prior calls, we continue to make significant investments in growth initiatives, such as our Dealer Management System, InventoryPro, the Aftermarket Network, the Accessories Network and the Independent Dealer Initiative. These investments are integral to ensure growth in 2008 and beyond.

Capital expenditures for 2008 are expected to be between $16 million and $18 million. Our guidance assumes an effective tax rate of 39.3%. We are pleased to be able to provide guidance that demonstrates our ability to grow revenue in a range of 15% to 18% even in this challenging economic environment.

Our expected profitability is strong; particularly when you consider included in our guidance is the cost to protect our intellectual property and costs associated with the incremental investments we are making in important initiatives that will be the source of continued growth of the business. We also believe that the current economic environment is conducive to completing targeted strategic acquisitions. And as in prior years, we will look to continue to employ over $220 million in cash and short-term investments on our balance sheet to add to our growth and to our profitability.

That concludes our formal remarks for this call. We will now turn it over to the operator and take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question today will come from Chris Mammone with Deutsche Bank.

Chris Mammone - Deutsche Bank

Hi. Thanks, guys. Just a question on the Markman trail: I guess the first is, how much did you spend in legal expenses in '07, and is the $7 million an accelerative pace from that?

Mark O'Neil

Yes. It is in a tight risk market. It is an accelerated phase. It's around incremental $4 million.

Chris Mammone - Deutsche Bank

Okay. I guess, what's the reason for that, and is it also a possibility that this -- depending on what the Judge says, I guess coming up eminently or we're expecting that first decision from the Judge. I mean, is there a chance that this trail could actually ramp-up sooner, and you wouldn't spend that much this year?

Mark O'Neil

I think it's too early to come on that. We do expect an answer in the next 30 days or so from the Judge on them relative to the Markman hearing. Until we can look at that in detail, we can't comment on what we're going to do or not to. The trail is scheduled for July. And I think the good news in this story is by all reasonable accounts, we expect this litigation to be over and done with next year. And let's pick up the $0.10 per share and move forward. So that's the goal. Commenting more on litigation is really hard at this point, because we just don't have anymore specific information.

Chris Mammone - Deutsche Bank

Okay. And then as a follow-up, I think you mentioned in your prepared remarks, when talking about the transaction business that the current environment is likely persist through the first half, what I guess, what do you expect could change in the second half that might improving environment there?

Mark O'Neil

Well, one of the things that is clearly out there publicly is, virtually anyone is forecasting auto sales expects a stronger second half than first half, and I think that's mostly driven by the economic stimulus that's being brought into environment by the Fed. Now, we don't know, I mean for certain or basically our forecast assume that we're going to be somewhere between the $15.5 million and $16 million rate, that's consistent with everyone else's forecast.

Now, we're being very cautious going into the year, because of the behavior we saw in the late fourth quarter and early first quarter here, with lenders aggressively turning back originations, particularly in the subprime arena. The capital markets freed up, along with the subprime.

Lenders will tell you that they do more lending. And again, everyone discusses the market is that, it will free up. We're probably somewhere in the middle ground there, not certain of it, well, if it does that's great news, if it doesn't I think we've addressed some of that, if it get much worse. I'm not sure we've addressed but, again, it's a little bit of unknown at this stage.

Chris Mammone - Deutsche Bank

Okay. And then I guess one last one, I'll get back in queue. Could you just give us an update on the Asbury installation?

Mark O'Neil

They're going terrific, on plan, on schedule, happy customer, and great execution on our end.

Chris Mammone - Deutsche Bank

Okay. Thanks, guys.

Mark O'Neil

You're welcome, Chris.

Robert Cox

Thanks, Chris.

Operator

Next in our queue is Tom Roderick from Thomas Weisel Partners.

Tom Roderick - Thomas Weisel Partners

Hi, guys, good afternoon.

Mark O'Neil

Hi, Tom.

Tom Roderick from Thomas Weisel Partners

And Mark, I was hoping you could just clarify your comments, I think in your script you mentioned something about subprime lenders, perhaps cutting off dealers are cutting back in the number of dealers that they are interacting with. Can you just clarify what's specifically is happening, as we see folks like AmeriCredit turning back on their loan originations. Are they actively reducing the number of dealers that they're working with? How does that directly impact you?

Mark O'Neil

Good question. Yes, and look without giving anyone individual lenders specific numbers, I can tell you that among a, call it, two handful of lenders, almost 4,000 dealers were cut off in the fourth quarter from lenders origination pipeline. And that's a cumulative number; there is a lot of overlap in there. So, for example, I am not giving again anyone's specific numbers, Capital One could have cut off dealer A, B and C, and AmeriCredit could have cut off dealer C, D and E.

And you find overlaps, so that's why our dealer count didn't drop precipitously but did drop a bit. But 4,000 dealers means that, where cases, where a dealer was maybe sending four credit apps to four different subprime lenders, maybe only has the ability to send the three right now, therefore, reducing some of the transaction opportunity. Now in some cases, credit unions and regional banks and others will step in there, but we don't think those step in on a one-for-one basis. That makes sense?

Tom Roderick - Thomas Weisel Partners

It does, and maybe that's a good commentary with respect to how you created your guidance for the coming year. Are you anticipating this sort of dynamic to continue to take place throughout 2008, or is the guidance sort of making the assumption that this was a one-time chop down in the number of dealers that subprime lenders will work with, and we will sort of see a stabilization after that?

Robert Cox

Yeah, for the most part we think the aggressive chopping has been done. Now I think it has been done in the context of an expectation to be able to go to the capital markets and securitize the majority of the originations that figures subprime lenders expect to originate, should that change drastically. Should they go from -- and I think some of the probable remarks are 25% pullback, 30% pullbacks. Should that get more aggressive, then I think we would see another drop. I think we have seen most of it now, and they have tried to align their origination pipeline with the dealers who can provide them loans. No reason to think it will get much worse, if it got a little worse, that's probably okay. If it gets a lot worse, then we'll probably come back to you.

Tom Roderick - Thomas Weisel Partners

Okay, that's very helpful commentary. Thank you.

Robert Cox

You are welcome.

Operator

Move to SunTrust, Andrew Jeffrey.

Andrew Jeffrey - SunTrust

Good afternoon, guys.

Robert Cox

Hi Andrew.

Andrew Jeffrey - SunTrust

One of the things I noticed is the volume-price mix on the transaction side. It looks like volumes are down, not at least sequentially down a lot, not up. However much year-over-year not terribly surprising in the environment, but pricing on a revenue per transaction basis certainly improved. Can you talk a little bit about that dynamically? Is that something specific to the quarter or something we might anticipate prospectively?

Robert Cox

Well, Andrew, I think -- and this is Bob -- our expectation is that not necessarily in a linear fashion, but certainly over the course of time that our average price-per-transaction will increase, and we expect that for two reasons. One is the new participants on the network -- and think about a small lender joining last year, we added -- if we started the year at about 03/05, we went up and more actually had about 500 now, so almost 200 lenders have joined. Many of those lenders are paying at our highest-price tier. So as they work their way into the transaction counts, they are obviously doing that at a higher price. So, that clearly adds to average price.

And second, most of our additional products, we mentioned eDocs, we mentioned eContracting, we mentioned the Aftermarket Network, assume with the rollout the accessory network, those are all higher-priced products. So, it's both customer mix and its product mix that will drive the increase. And again, I don't think it will happen in a linear fashion, but I think that over the course of time as you have seen here from Q2 to Q4, you will see a steady increase in that average price.

Andrew Jeffrey - SunTrust

Okay. And then, as you look to at least the first half of ‘08, would you expect to see down transaction volume year-on-year?

Robert Cox

I don't think we expect to see down transaction volume. In fact, we do expect growth just not our normal expect growth rates.

Mark O'Neil

Let me clear it in another way. We've modeled transaction volume for the year internally. We don't give out specific guidance on transaction subscriptions for the year. We have obviously also given a guidance range of showing revenues up 15% to 18%. We assume most of that growth or the majority will come from subscriptions as the transaction will grow. How fast? Again, we're being a bit cautious here until we get it further into the year, and get a good read. We have six weeks under our belt -- hardly a good part of the year, and I think we’re comfortable with the numbers that's what we are starting to see.

I think it will be enough again, we will be very communicative call-to-call, but I don’t think we want to try to segment out quarter-to-quarter or first half second half, transaction versus subscription growth. I think we are looking at our history, good strong track record of hitting the annual number, we've always said, it's a bit difficult to forecast the quarters particularly with the segment transaction subscription and from what we see now, we feel good about the year.

Andrew Jeffrey - SunTrust

Okay and then just one last one, if I may? You may have mentioned it, and I probably just missed it? Could you give me the number of dealers that currently subscribe to at least one product?

Robert Cox

No, we probably didn't mention that Andrew, but that is 12,980 dealers as of the end of the fourth quarter.

Andrew Jeffrey - SunTrust

Okay. Thanks, guys. Thanks a lot.

Operator

Our next question will come from Peter Goldmacher with Cowen.

Peter Goldmacher - Cowen

Hey, guys, I just wanted to ask you a quick question. Talking about the mix shift going forward, if I understood your guidance correctly, it looks like operating margins are going to comedown by about 250 bps. Does that mean that you’ll be investing more heavily in the services -- in the subscription business?

Robert Cox

It reflects two things, Peter. One is the nature of transactions when we pull back they have a transaction volume a bit, given what we are seeing in the sub-prime world, every dollar of transaction revenue on the margin you pullback is $0.99 or close to $1 as you can be in earnings or EBITDA in this case.

So, pulling back transactions has a lot of impact on the bottom line. That said concurrently we do feel like this is the year to continue to invest heavily we’ve invested a little more in DMS than we originally anticipated. I think we told everyone last year that we're investing in DMS in the forms of roughly of 40% capacity increases. I'd say we're little bit closer to the 50% right now, and frankly, I think that could even tick-up a little bit based on the significant demand that we're seeing.

And we're also investing, still fairly heavily, on independent dealers in the Aftermarket initiative, because, again, we think this is a time when others aren't investing, let's get aggressive, let's continue invest heavily because that will position us for continued growth in 2009, whether the industry gets out of it's slump or not.

Peter Goldmacher – Cowen

So, when you guys look out two or three years, and you get the transaction, the one origination volume -- flattish in growing with somewhere close to auto sales, what do you think the, say, run-rate property margins should be further as the software business becomes the growth business?

Mark O'Neil

Yeah. One other things we've said consistently for the last few years is we expect EBITDA margins to increase. I think what you're using as a proxy for operating margins. We still believe that this is a year where we're continuing to heavily invest and instead of pulling back in that while the industry is seeing a better contraction that is margins as you pointed out, 200 plus basis points.

I feel pretty comfortable saying as we go into 2009, that we're back to the 28% plus. And I think then it grows in a step-function, much as it has historically, and I might see here 28%, 28.5% and then might see another 50 or 80 basis points the next year, or you might see 20 basis points and then 80 basis points. It's going to continue to expand. We're still very confident in that. Nothing has changed in that story. This is just a year where we want a little bit of accretion. I want to keep investing in the business.

Peter Goldmacher – Cowen

Just lastly, you gave us some qualitative perspective on what the lenders are doing. How are the dealers reacting today? Are they able to find their wallets, or is it getting hard for them to spend on incremental things for the business?

Mark O'Neil

I was just talking to about nine or 10 of our sales folks at lunch today. And really the same comment I heard from them that I heard at NADA. I think there are two groups of dealers out there. I think there are the group of dealers out there that are saying, “hey, times are tight, and I am closing down my wallet,” and others were saying, “times are tight, I am going to look extra hard at how I can invest in technology to get even more productivity out of the folks I have or potentially reduce my salary cost.”

And obviously, we are focused more on the later. We were really pleased with what we saw at NADA. I think we will continue to see this year much as we did last, a very healthy growth rate well over our average growth rate in the subscription arena while we'd see our place softening in the transaction growth area.

Peter Goldmacher – Cowen

Which of those two groups is bigger?

Mark O'Neil

Well, today, look, subscriptions are one-third of the total in round numbers, and transaction are two-thirds. The good news is looking last year, subscriptions grew well over 40% and that includes with the slowing -- and the slowing didn't just start on January 1st. I mean we saw the slowing going into the second half of 2007. And I am not going to give you a specific number, but we'll, given transactions versus subscriptions in 2008, we can assure your subscriptions will grow significantly faster than transactions for the most part as it did in 2007.

And we feel good about some of the new transaction products. And if you look at the independent dealer initiative, you look at the Aftermarket network, you look the Lease network, you look at eContracting, edocs, we see pretty healthy growth in that segment, in all of those products going into this year. And so, we remain very bullish on those. It's just credit apps that we are being cautious about until we get a better reason on the year.

Peter Goldmacher – Cowen

Okay. Thanks, guys.

Mark O'Neil

You're welcome.

Operator

Next person in the queue is David Scharf with JMP Securities

David Scharf - JMP Securities

Hi, good afternoon.

Mark O'Neil

Hi, David.

David Scharf - JMP Securities

Few things. Mark, can you speak to what your underlying expectations are underlying your guidance for the number of lenders to be added this year. I mean, should we still be expecting about a 120, 150 per year for the next several years, or do you feel you're running out of some runway there?

Mark O'Neil

No. We don't feel like we're running out of runway. I think the 2008 number will be similar very to 2007 or 150-plus within the year. In fact, I feel pretty good about that number. So, expect that -- and well, that's part of the offset on the subprime guys pulling back a bit, and adding new lenders is a bit of offset there. I feel good about their lender pipeline right now. And frankly, I think I have some slight potentials even accelerate, although it's too early to make that call. So, we're not, we are going in with same as those ever.

David Scharf - JMP Securities

Great, great. And can you take this opportunity to maybe to speak once again to how we ought to think about the mix of the lenders particularly prime versus non-prime, and given that subprime applicant probably generates more applications than a prime borrower. Sort of a rule of thumb for us to think about in a modeling as far as what percentage of the company's transactions are generated by non-prime borrowers?

Robert Cox

I can tell you almost surely, there will be no new non-prime lenders coming on the platform in 2008. The bulk of those that are joining the network are credit unions and regional banks. That's well over 70% I’d put in that category, in fact, and maybe it's close to the 80% to 85%.

And frankly, those lenders are much more what I would call full-spectrum lenders, maybe the high end of subprime, or near-prime all the way through super-prime, and that's the lender that will come on. There are very few peer-play subprime lenders out there. In fact, to my knowledge, we have none specifically coming on this year. In fact, I am not sure there are any even available to connect other than the large national ones already out there. So, I assume that's good for us, it’s a nice balance mix of lenders coming on.

Now the good news is both regional banks and credit unions tend to underwrite very differently than what I would call the full spectrum either national or super-regional lenders. A credit union can look at a 580, FICO score, which by all accounts anyone would consider a subprime credit and might write that more like a C, a near-prime or even a marginal-prime customer, because that customer has been a long customer of the credit union, has performed very well maybe on a prior auto loan with that credit union or maybe even a current home mortgage. And so that’s good from our perspective, because that will be very competitive in writing the incremental auto business. And that’s the primary lender that's being added to the network.

David Scharf - JMP Securities

Alright, what about retrospectively, we're looking at the 90-odd million of transactions last year, how many of those were generated by nonprime borrowers? I'll we liaising the definitions a little fluid as you just described?

Robert Cox

It’s very fluid, and we don’t break that number out.

David Scharf - JMP Securities

Okay, fair enough. On the Independent side, can you talk a little bit about what’s going on in that market? Obviously that’s used cars, so I would imagine the component of subprime or nonprime is even higher among the independents. Are they sort of the first dealership to get cut off by these lenders and inversely on the software side -- maybe some commentary about their spending patents lately?

Robert Cox

Two very good questions. Let me start on the transaction side first. I will be quite candid in saying we're leader with launching the independent dealer product than we had hoped. In fact, we are hoping it would pull up more of the near-term slack that we see in terms of the softening subprime credit app volume. But what happened is, as we are going and again, a lot of this behaviors isn’t new as the January, we are seeing it into the third and fourth quarter last year.

But early fourth quarter, a number of lenders who had indicated that they wanted to be first to connect to the independent-dealer platform actually backed out because strategically, they said, “hey, no lending to independent dealers -- that's a bad segment,” much like people are characterizing subprime customers as bad or “got to stay away from them.” It's a little bit of throwing the baby out of the bathwater, but its just knee jerk reactions, and we don’t want to go there.

Even though the whole rational behind the independent dealer initiative was to make an independent car dealer look just like a new car franchise dealer in terms of risk to the lender, but that was their choice. It did impact us. They pulled out and said they were going to wait till second half of '08. So we needed to go out and sell other lenders to come on to the platform to launch it and indeed we've been able to very successfully do that.

We've replaced the three, what I'll call, national lenders with more like super-regional or big-state lenders, and the pipeline continues to grow. But we lost a couple of months in the process. So that product will launch. I don’t see these lenders pulling back. In fact, they are looking at as an opportunity to grow auto originations while others are pulling back. And Fireside will be the first lender up and running. Should be running very shortly here. They are in California, which is a good, large auto market obviously, and in a couple of states, I believe, beyond that as well. I am not certain of that. And so they are up and running.

There are two others we haven’t announced yet that we are starting connectivity with. So as we move into the second quarter, we should start to see some volume out of this and be able to talk more significantly about the initiative. But we are excited about this network. There are both dealer transaction fees, lender transaction fees and subscription fees.

Now, that touches on the second part of your question, which is about software to these dealers. We clearly see demand for DMS light product from these folks, i.e. the DMS product that doesn’t necessarily have a parts and service module. That's one subscription product we are excited about although we are capacity constrained there and don’t expect to sell a lot of DMS into the independent space. We also anticipate the independents. They are being very interested in our inventory products, our menu products and a couple of other of our lower-cost subscription products such as BookOut. So we see that market is wide open and expect some of our subscription growth in the second half to come from that group.

David Scharf - JMP Securities

Okay. Great. And I have just a couple more. With respect to Arkona, obviously ADPM some others to speak to having sort of a, like you say, DMS light or a hosted offering. Is there change in the landscape there competitively, particularly after the Asbury announcement or perhaps the big legacy DMS vendors are taking a look at getting more aggressive on their pricing or putting more development of sales resources in their hosted solutions?

Mark O'Neil

Yeah. You're going to see more news for us, let me just say the DMS carryover next quarter and two, we're very excited about that business. Look as we are demoing the product at NADA, we had to apply an additional sales folks to do demos. We had more dealers, dealers groups coming to look and talk to us about our DMS offering. Then frankly we could possibly expect it. It's just there is significant demand out there.

There are lots of dealers who aren't happy with their current alternatives and are looking for alternatives. And as I said, in my prepared remarks, I think the majority of dealers that we're interacting with right now are characterizing, offsets the tier-one alternative that there has been a significant shift. It's now DealerTrack Arkona DMS and two alternatives, and then it's a second group. And we are getting consideration, which is just what we wanted by virtually everyone out there who is considering switching DMSs.

David Scharf - JMP Securities

Got you. And just one last question for Bob. Little help on some of the line-items going forward, product development expenses obviously ticked up this year, as a big investment with the Arkona coming on board, what about in '08 sort of that $9 million, $10 million level in aggregate product development expenses or should we be looking at a bigger number?

Robert Cox

No, David, I think that's a reasonable place to be for next year, yes.

David Scharf - JMP Securities

Okay. Great. Thank you.

Mark O'Neil

Thank you.

Operator

We have a question from Franco Turrinelli with William Blair & Company.

Franco Turrinelli - William Blair & Company

Hi, guys.

Mark O'Neil

Hello, Franco.

Franco Turrinelli - William Blair & Company

I don't know, I forget if that was you, Mark or Bob, that made the comment that you are expecting to use or targeting to use your cash to add to grow some profitability through acquisitions. But I guess question is that I think acquisition to-date have been somewhat diluted. Take us through your thinking for 2008, given the trade-off it's, clearly, already being made between expanding margins and investing in the future as to how you would think that through for acquisitions?

Mark O'Neil

Yes. That's a good question, Franco. Obviously I have to comment generally here since it's hard to comment specifically on future or potential future acquisitions. If you look at our history, we've done three deals a year or four deals for the last three or so years. The pipeline has only grown, its not shrunk. Generally, acquisitions have been very mildly dilutive and only in the short-term.

That said, we've had many of our acquisitions exceed our expectations over the longer term. And I think we are commenting recently certainly at Deutsche Bank Conference recently, I believe at a Thomas Weisel Conference before that, that if you look at the Akrona acquisition, we said we acquired business was very low EBITDA margins in the 4% to 7% range. We said it would take three years to get that business up to the DealerTrack average margins, and we're referring to roughly 28% number.

We have said that we will think we'll substantially beat that as we look forward, and I think that's the testament to, however, integrating the acquisition we're doing. There are more out there. I don't, look I don't what they will do specific at earnings. We're very cognizant and wanting to minimize particularly the EBITDA dilution or the earnings dilution. I won't say we're not going to do that, but I am going to say we're going to be cautious, and I don't see anything in horizon that I would call very dilutive, and on a flip side , we've seen one or two transactions. The year might even be accretive, and we can consolidate quickly enough.

So look, it's really going to matter here -- or it’s going to be determined by deal-by-deal. The only other comment I want to make is that obviously our guidance is exclusive of any acquisition, and I think, what we gave you 15% to 18% revenue growth. I feel fairly comfortable saying that probably another 5%, you might argue there is 7 or 8, even higher, percent incremental revenue with acquisition I think that still holds true as we look the pipeline for the year. So that should get us well north of 20% rate and again rely on our track record historically had being, is doing a very good job integrating those in creating EBITDA margin growth as quick as we can.

Franco Turrinelli - William Blair & Company

Just help me, run through this again for me, I mean obviously, in the past, one constant has been your ability to expand margins as you've expanded the revenue, and for 2008 we're still taking a little bit of a pause in that process, I hear what you've said about it being particularly related to the pressure on the transaction side of the business. But again, help me think through some of the decision-making process in deciding to continue to invest at the rate that you are investing and not going to protect that margin expansion?

Mark O'Neil

Yeah, well can I think this is again some an area where we have been very consistent of saying that we are investing for the long term here. We see lots of opportunities to expand the end-to-end technology platform that we are providing to dealers or the end-to-end technology solution, and we want to take advantage of that. There is no better time when everyone else is pulling back and worried about the future. They continue to demonstrate an ability to aggressively invest.

So, we are not but the first and foremost as we plan the year, we said regardless what happens, we have the balance sheet, we have the wherewithal, and we have the cash generation capability. Pulling back on investment is not as if we are going to position this business on a long term and really grow our share.

So we started the year without assumption, then we overlaid it and said, “what do we think could happen in the transaction world?” and look, I don't have to tell anyone on this call, but there is a bit of a credit crisis out there, and subprime is a pretty ugly word. Got a lot more than four letters, but it is certainly being thought of in terms of a four-letter word. And it's got us concerned enough that we are being prudent here in saying that look, obviously subprime originations are going to come down.

A number of the large public companies have given some specific guidance around how much it is going to come down. We have taken those numbers, and we frankly hair-cutted our transaction volume and by doing that we compressed margins. And again I think that's reasonably short-term. I just made the comment a bit ago that I think as we go into '09, I think we are back to the 28% level. I think part of that comes from litigation, and I think part of that comes from the growth of other businesses.

We don't need to hit it out of the park on all of the new growth initiatives. We just need to consistently execute on anyone of them. So whether you look at it as continuing to grow the DMS business, which I see is one of our most promising new subscription products growing faster almost that any other certainly more mature subscription product.

I look at the Independent dealer initiative, I look at the InventoryPro traction again a very hot product in NADA, terrific momentum with Manheim, we just indicated we had a GMAC to that product in terms inventory search capability, and I can assure there are more announcements coming there. I see good traction in those products.

They could be almost standalone between DMS and inventory; they could be much of our future subscription product growth. But the good news, I don’t think we're going to rollout for a line absolutely. We have our Congress to thank for giving us some wind at our back so they are Red Flags product by legislating the dealers have to act much like a lender institution as do to try to prevent identity theft. That really gives huge momentum to the Red Flags product at NADA.

Lot of encouraging subscription product news out there, we are very bullish on that. eDocs volume, I think you are going to see we are going to announce some new customers as we go through the year, here the pipeline is pretty health there. That could spill over in to eContracting and further drive transactions there.

So look, it may not be as great an environment as it would have been if we didn't have the subprime crisis, but we think it's still a pretty-healthy growth environment, and I think they are going for upside. We're obviously not talking about that here beyond with the guidance we've already given you, but I've to tell you we feel great about the year beyond with the guidance we've already given you, but I’ve to tell you, we feel great about the prospects as we look forward in the year. Does that help?

Franco Turrinelli - William Blair & Company

Sure does.

Mark O'Neil

Thanks.

Operator

(Operator Instructions) We’ll hear from Tom Roderick with Thomas Weisel Partners.

Tom Roderick - Thomas Weisel Partners

Hi guys, just a brief follow-up Mark, I’m sorry to beat a dead horse, but I just want to make sure we are all clear on this. So the 15% to 18% revenue guidance is for organic revenue guidance, and the notion of potential acquisitions that could come throughout the year could add say 5 to 7 percentage points of growth on top of that. Did I hear you correctly, there?

Mark O'Neil

Tom, the best way to look at that is 15% to 18% is exactly what you said. It's what we have on play today. Obviously, any growth from acquisition would be subject to, and there is certainly no guarantee there, but you've seen our history we are an acquisitive company we've got a pretty full pipeline of companies that we look at and continue to look at, but obviously no guarantees. Deals are subject to timing and subject to a lot of things. So, look we are hopeful that we can add to growth and to profitability, but that's obviously why we don’t put it in our guidance.

Tom Roderick - Thomas Weisel Partners

Okay, and then just to clarify on what's facing some margin pressure this year. Can you just repeat, Bob, what the hit is coming from litigation in terms of either EPS or absolute dollar impact this year and then what amount is coming from incremental R&D on the DMS side of the business?

Robert Cox

Sure, Tom. Part of our guidance is obviously the $7 million just for litigation costs. And that represents about $0.10 of both GAAP and cash EPS. Was that the first part of the question?

Tom Roderick - Thomas Weisel Partners

Yeah, it was the first part and then the second part just in terms of either incremental product development specific to DMS or just incremental product development, whichever you can speak to.

Robert Cox

And also, we haven't broken out either, but I can tell you if you look, simply look at our EBITDA rates. Going into the Arkona acquisition, we obviously told you we've pulled down 100 basis points or so, and we were investing in Arkona. Again, as Mark mentioned, that business is going from a 5% EBITDA Company in a few years to look a lot more like us. So you can imagine that we are spending a fair amount there of that incremental EBITDA squeezed that you're seeing. So a big chunk of it is indeed going to Arkona installation capacity, it’s going there in Arkona technology capacity and really did support that business in some of the other software businesses.

Tom Roderick – Thomas Weisel Partners

Okay. Thanks, Bob.

Operator

Our final question will come from Jordan Hymowitz with Philadelphia Financial.

Jordan Hymowitz - Philadelphia Financial

Hi, guys. I just want to understand a couple of things that's in the guidance. How much specifically is in the guidance for the warranty exchange?

Mark O'Neil

The warranty exchange...

Robert Cox

Aftermarket?

Jordan Hymowitz - Philadelphia Financial

Yeah, Aftermarket exchange are?

Mark O'Neil

..in network. Look, guys just a recap here, we don't break out any individual product, but look at as more as a cumulative investment. So with the Aftermarket network is continuing to consume a lot of resource as we connect, the incremental players that we have signed which is roughly 15 incremental ones from 20 we've connected, one of the larger one there is APCO, someone we're very excited to get up in running, and we'll be up running in the second quarter to help get that network a shortening arm. But look out I can't give you the individual investment in Aftermarket network because we don't breakdown our numbers at a product level.

Jordan Hymowitz - Philadelphia Financial

Can you give us an update as the eContracting from last quarter what the percent of transactions that are going to eContracting? I think it was 17% last quarter -- 17% of lenders were on eContracting or how we defined the last quarter?

Mark O'Neil

Well, we don't breakdown as a percent of lenders. So I will do the math real time. In fact 17% is way too high. There are 500 lenders on the network right now. There are 24 lenders available on eContracting. So you can do the math for me right there up to 5%.

Jordan Hymowitz - Philadelphia Financial

But those are the much bigger lenders and not the smaller lenders. So in terms of….

Mark O'Neil

Yes they are and they represent -- last count about 35% to 40% of the potential originations out there. But that said, that's the product, again, we need more of a ramp. We do need more lenders. We are working hard to try to get another captive to participate on eContracting. We think that will make a significant difference there. And in between now and then, we're still trying to get incremental lenders to sign up.

The offset there has been, we've got a pretty good pipeline on eDocs, which is very similar transaction revenue, and one of the reason we invest in that business, we thought as a stepping stone to get lenders on eContracting, and we still see that, and I expect to see probably more of the growth there this year with the later part of '08 into '09, seeing some of the shift from eDocs to eContracting.

Jordan Hymowitz - Philadelphia Financial

Let me try at one more thing, then. I mean your guidance ex the litigation charges 119 -- the incremental charge is 119 to 124. Approximately, if there was no incremental spend on the Aftermarket exchange or other new products, what will be the core organic number approximately? In other words, how much of some of these new products are actually being negative to earnings. See my question?

Mark O'Neil

We see it. Another way to ask the same thing in a way that we're probably not going to get on the path, but let me just confirm that your numbers are in the ballpark there on the approximately incremental litigation there. Look, again, we don't breakdown the specific products, but there is clearly some of the pullback in EBITDA margin is very much attributable to investing in the broad suite of new initiatives, which includes DMS, includes Aftermarket Network, includes Independent dealer initiatives, includes the Accessory initiatives and to a lesser degree the lease network.

So, the cumulative group is being invested. And look I stand by the statement I made earlier, which is these are all significant investments, but they don't change our confidence and our ability by 2009 to get back to the 28% plus EBITDA margin number we have been hitting.

Jordan Hymowitz - Philadelphia Financial

Okay. Thank you.

Mark O'Neil

You're very welcome.

Operator

That does conclude the question-and-answer session. Ladies and gentleman, thank you very much. And Mr O'Neil, I will turn the call back over to you for any additional or closing remarks.

Mark O' Neil

Let me just reiterate a point that I have made a couple of times today, which is look, anyone invested in the DealerTrack story, two and half years ago when we took the company public, the story is even better today than it was than. We're a much stronger company from a financial perspective. We're much more diversified than we were from a revenue perspective. We've made a number of investments and developed a lot of new products that have, I think a terrific future. When we took the company out we thought we had $1.6 billion market opportunity. We think that number if now closer to $4 billion to $5 billion. So, we've substantially increased the adjustable market.

We had the wherewithal to successfully execute in that larger market, and I think that's a great story. If you like the story then you should like it even more now. We're telling you then in 2008, we're continuing to be a company that invests for the long-term to continue to develop the story. And I think the story is even better than it was back than and I remain very bullish on our business.

So I think there is lots of good things in our pipeline, lots of things that we can't talk about detail here, but internally the management team remains very excited about the potential for the business. And frankly as representatives of our investor team, I think you ought to as well.

So thanks for your support up till now and here as to your continued support as we go forward and continue to execute the story that we've been executing over the last couple of years. So thanks everyone. Really appreciate you supporting our story. We think it's great one. Take care.

Operator

Once again thank you all very much for joining us today. That does conclude the presentation. Have a great afternoon.

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